China and the World of Business • China Business and the World

According to the Financial Times, Huawei has decided to unravel its deal to buy the intellectual property of Silicon Vally firm 3Leaf rather than risk a finding by President Obama that the Chinese telecommunications equipment manufacturer was in violation of the law.

That was a wise move, and perhaps the smartest thing Huawei has done with its government relations in a long time. Sadly, they do not go far enough, because while the solution addresses the most pressing issue – the 3Leaf deal – it does not help Huawei with the far more fundamental problem it faces.

Huawei has a trust issue in America of such magnitude that it all but closes the door to the company in the US market.

Starting with a Trust Deficit

Huawei starts in America with three strikes against it. First, it is foreign, and there is enough latent xenophobia in the United States to any form of direct investment from offshore a political challenge, even in the best of times. This is not the best of times, and no matter how bad the economy gets, nobody likes the idea of selling America’s innovative crown jewels (i.e., Silicon Valley companies laden with valuable intellectual property) just to keep the lights on.

Second, Huawei is Chinese. The level of suspicion and distrust of Chinese companies in America is high, rooted in causes too diverse to mention, from lead-painted toys to alleged currency manipulation, from movie piracy to industrial espionage, and from political causes from China’s handling of dissent to its opaque defense agenda. Giving the greatest possible benefit of doubt, Huawei is guilty of none of this, but the fallout of such a record – as an early international emergent from China’s corporate cauldron – falls upon the company nonetheless.

Third, Huawei’s links to the People’s Liberation Army are still not sufficiently transparent to sever the two in the minds of American regulators. Whether this is fair or not is hard to say. The company protests that there are no ties at all. But the opacity of China’s military-industrial complex, coupled with the nation’s ambitions, its focus on network-centric warfare, and the status of the company’s founder as a PLA veteran eat away at the credibility of such statements. The court of public opinion, as it were, rules against Huawei on this count.

So despite the company’s statements to the contrary, it clearly has not done anywhere near enough to overcome those issues in the U.S. As such, even before the 3Leaf deal came up, Huawei had a serious trust problem in North America. The company’s leaders either did not know this was a problem (thus proving that they are ill-informed and out of touch with the U.S.,) or they disregarded it as a serious issue (thus proving they were either foolish or arrogant, and, again, out of touch.)

For had the company known this was an issue and appreciated its severity, they would have done much more to solve it before they went shopping in Silicon Valley.

Sneaky and Opaque Are No Way to Go Through Life, Son

All of which made the entire 3Leaf deal look sneaky and underhanded, rather than smart and well-handled. Had Huawei bought 3Leaf as an outright acquistion, the company would have been expected to ask the Committee on Foreign Investment in the United States (CFIUS) for approval. Instead, Huawei waited for 3Leaf to declare insolvency, buying up assets and hiring staff. This may have been technically legal, but as Huawei discovered, it is perceptually suspect.

An untrusted company and tactics that arguably skirt the intent if not the letter of the law is a bad combination, bad enough that retrospect should not have been necessary to know that a more careful approach was necessary. As it is, had Huawei gone to the CFIUS for approval in the first place, and had the answer been “no,” Huawei would still be ahead of the game: they could have earned perceptual points for going through the process and for being upfront. Now, they have four strikes against them: foreign, Chinese, the alleged PLA connection, and sneaky.

This raises another question: why? Maybe they were arrogant. Maybe they were ignorant, even willfully so. If you believe either of those answers, you must accept that Huawei is many years from being ready to operate in developed, transparent, regulated markets. If you reject that line of thought, the only other compelling answer is that Huawei believed that what it would get from 3Leaf was so valuable that it was worth more to them than the trust of the industry, the US government, and by extension the American people. What could have motivated a company to burn such bridges?

Given that the Pentagon flagged the Huawei/3Leaf situation to the CFIUS, it is entirely possible that Huawei was engaged in the acquisition of technology that would have been beneficial to the defense of China at the expense of the U.S. For Huawei’s sake, I hope this was not the case, for if it was, not only is Huawei’s name in America under a cloud, so is its credibility in Europe, in India, in Russia, and elsewhere, for it will have proven by its actions that it serves the Chinese defense establishment before its own interests, thus undermining its earnest protests to the contrary.

Somebody Snitched

While we ponder this, let us not forget that there are unanswered questions on the U.S. side as well. We know that the Pentagon dropped the dime on Huawei to the CFIUS. What we do not know, and what we may never know, is who dropped the dime on Huawei to the Department of Defense? Who told somebody in the Pentagon “hey, guys, you need to look at what is happening and go for the block on this deal.” If it was a competitor, this is politics, plain and simple: some smart company may well have capitalized on Huawei’s lack of trust in the US to block this.

We could go Ian Fleming on this situation ad nauseam. But there are three essential takeaways.

Three Problems, Three Fixes

First, Huawei has a slow-burning but serious trust crisis that it must move immediately and resolutely to resolve if the company is not going to find itself the object of suspicion in the U.S. and elsewhere, and thus locked out of countless deals for non-commercial reasons.

Second, Huawei has proven itself a tyro at navigating the U.S. political and regulatory process. It needs to take drastic action to rectify this problem and repair the damage done this far, or it can write off the U.S. market for the foreseeable future. (Which I think they should anyway, because pickings are better elsewhere, but that’s another issue.)

Third, the morass around cross-border mergers and acquisitions continues to deepen. Eighty percent of the problem in this case was poor communications on Huawei’s part, but the other twenty percent is a problem in the global foreign investment regime. Standards of approval for foreign investments are made on a country-by-country basis, are thus inconsistent, and are becoming a growing source of friction between countries that could easily (in the case of the U.S. and China particularly) devolve into a costly and profitless tit-for-tat rejection of each other’s investment forays.

Just as was done with trade, first through GATT and later the WTO, China and the U.S. need to lead the way toward the forging of a more transparent and consistent global regime governing direct investment.

These lessons would be well-learned by other Chinese companies seeking access to overseas markets or intellectual property via acquisition: the deck is stacked against you before you start, so play accordingly.

One thing I do not understand is this: Why is Huawei (and other Chinese companies for that matter) not focusing on growth regions where they do not have the “three strikes” against them? For example, places like Brazil, Argentina, Middle-East, etc… These places are dominated by players like Cisco and Siemens which are extremely expensive, but do not have a strong mid-end player. Huawei could position themselves as the “so-so” solution (reasonable quality at reasonable cost), which is really lacking in these countries, since they do not have the environment for their own homegrown technology (at least telecom-related)

Felipe, you have asked the RMB 64 billion question. You and I agree that the common-sense approach to internationalization for Chinese companies lies through emerging and developing economies, not Japan, Korea, North America, or western Europe.

The only answer I can offer is that somehow Face must trump Business Sense when the time comes to make these decisions. Either way, a lot of Chinese companies are about to pay a heavy tuition for learning that, once you wander far from home, face falls in value really fast.

In fairness, Chinese companies are not alone in their vanities. That does not excuse them, however, from recognizing the more egregious ones and dealing with them.

I think in terms of markets, Huawei is already in the Middle East, South America and especially Africa with their “so-so” solution approach. In this case, it is the attempted acquistion of a technology firm with valuable IP in the US.

Understood. Huawei has also tried to make inroads into the US as a market, not just a source of acquisitions. It’s an ill-advised play. They need to deepen and fortify their positions in the third world first. Otherwise, long term, they’re going to get picked apart.